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what is ROEL - ROEU?

what is ROEL - ROEU?

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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**Financial Analysis of New Product Financing Options** You are working for the CEO of a new company planning to manufacture and sell an innovative watch, featuring an embedded TV set and a magnifying glass crystal. The decision at hand involves the method of financing this venture: with equity only or with a mix of debt and equity. The expected operating income stands at $500,000. **Scenario Analysis** Presented below are two scenarios detailing the firm's financial structure: **Scenario 1: 0% Debt (Scenario U)** - **Operating Income (EBIT)**: $500,000 - **Required Investment**: $2,500,000 - **Percentage of Debt**: 0% - **Amount of Debt**: $0 - **Amount of Common Equity**: $2,500,000 - **Interest Rate**: Not Applicable - **Tax Rate**: 35% **Scenario 2: 60% Debt (Scenario L)** - **Operating Income (EBIT)**: $500,000 - **Required Investment**: $2,500,000 - **Percentage of Debt**: 60% - **Amount of Debt**: $1,500,000 - **Amount of Common Equity**: $1,000,000 - **Interest Rate**: 10% - **Tax Rate**: 35% **Objective:** Determine how the firm's expected Return on Equity (ROE) changes with the inclusion of debt. Calculate the difference between the ROE when leveraging debt (ROE_L) and the ROE with all equity (ROE_U). Do not round intermediate calculations. - **Options for the difference in ROE:** - a. 11.21% - b. 8.29% - c. 9.75% - d. 11.70% - e. 8.78% Analyze the provided data and select the correct option for the change in expected ROE due to debt financing.
Transcribed Image Text:**Financial Analysis of New Product Financing Options** You are working for the CEO of a new company planning to manufacture and sell an innovative watch, featuring an embedded TV set and a magnifying glass crystal. The decision at hand involves the method of financing this venture: with equity only or with a mix of debt and equity. The expected operating income stands at $500,000. **Scenario Analysis** Presented below are two scenarios detailing the firm's financial structure: **Scenario 1: 0% Debt (Scenario U)** - **Operating Income (EBIT)**: $500,000 - **Required Investment**: $2,500,000 - **Percentage of Debt**: 0% - **Amount of Debt**: $0 - **Amount of Common Equity**: $2,500,000 - **Interest Rate**: Not Applicable - **Tax Rate**: 35% **Scenario 2: 60% Debt (Scenario L)** - **Operating Income (EBIT)**: $500,000 - **Required Investment**: $2,500,000 - **Percentage of Debt**: 60% - **Amount of Debt**: $1,500,000 - **Amount of Common Equity**: $1,000,000 - **Interest Rate**: 10% - **Tax Rate**: 35% **Objective:** Determine how the firm's expected Return on Equity (ROE) changes with the inclusion of debt. Calculate the difference between the ROE when leveraging debt (ROE_L) and the ROE with all equity (ROE_U). Do not round intermediate calculations. - **Options for the difference in ROE:** - a. 11.21% - b. 8.29% - c. 9.75% - d. 11.70% - e. 8.78% Analyze the provided data and select the correct option for the change in expected ROE due to debt financing.
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